Variable interest rate

Definition

A variable interest rate is an interest rate on a loan or security that fluctuates over time based on changes in a corresponding benchmark or index. These rates can adjust periodically, affecting the amount of interest owed by the borrower.

5 Must Know Facts For Your Next Test

1. Variable interest rates are typically tied to a benchmark such as the prime rate or LIBOR.
2. Monthly payments on loans with variable interest rates can increase or decrease as the rate changes.
3. Variable interest rates often start lower than fixed rates but carry more risk due to potential increases.
4. Lenders must disclose how and when the interest rate will change for loans with variable rates.
5. Caps may be included in some loan agreements to limit how much the variable interest rate can increase.

Review Questions

• What benchmarks are commonly used to determine variable interest rates?
• How do variable interest rates affect monthly loan payments?
• What is one advantage and one disadvantage of choosing a loan with a variable interest rate?

Related terms

Fixed Interest Rate: An interest rate on a loan that remains constant for the entire term of the loan.

Prime Rate: The lowest rate of interest at which money may be borrowed commercially, often used as a benchmark for other loans.

LIBOR (London Interbank Offered Rate): A benchmark rate that some of the world’s leading banks charge each other for short-term loans.